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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 5% and inflation is expected to be 18% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk? (Hint: Refer to “The Links between Expected Inflation and Interest Rates: A Closer Look” on page 206.)

Summary Introduction

To identify: The actual yield on 4 year securities.

Introduction:

Yield:

The yield is the percentage of the securities at which the return is provided by the company to its investors. Yield can be used in the form of dividend and interest.

Explanation

Items required for the calculation of actual yield are risk free rate and the inflation premium.

Given,

The real risk-free rate is 5%.

The inflation premium is 18%.

Formula to calculate the actual yield on default free security,

r=r*+IP+(r*×IP)

Where,

  • r is actual rate.
  • r* is the risk free rate.
  • IP is the inflation premium

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